Key Takeaways

  • Restricted share rights vary based on the type of equity (RSA vs. RSU), company policies, and applicable state law.
  • RSAs typically confer voting rights upon grant, while RSUs only offer them after vesting.
  • Vesting schedules can be time-based, performance-based, or a hybrid of both.
  • Some companies offer dividend equivalents on unvested shares or RSUs, depending on plan terms.
  • Restricted shares may be forfeited if employment or performance conditions aren't met.

In employee-owned companies, restricted stock voting rights are granted to or withheld from company employees. Whether employees holding restricted stock have voting rights depends on the type of restricted stock they hold and the state laws where the company operates.

Restricted Stock

Restricted stock describes company shares that are sold and bought under restrictions. In employee-owned companies, restricted stock usually refers to shares given to employees or shares that employees have the right to purchase, but which they can't take possession of until a later time when certain conditions have been met.

Often employees will gain access to shares after working for a company for a certain number of years or when they have met individual performance goals. If the employee doesn't meet the terms for the restrictions to be lifted, they will forfeit the shares. Depending on the company's vesting schedule, restricted stock could vest gradually or all at once.

Restricted stock might or might not provide employees with dividends or voting rights. Voting right rules and dividend laws vary state by state. Depending on whether state law permits it, a company's articles of incorporation can allow voting rights and/or dividends on unvested shares.

How Vesting Schedules Impact Share Rights

Restricted shares often follow a vesting schedule that dictates when the recipient gains full ownership rights. Vesting may occur:

  • Time-based: Shares vest gradually over a set period (e.g., 25% annually over four years).
  • Performance-based: Shares vest upon meeting company or individual performance milestones.
  • Cliff vesting: All shares vest at once after a certain period.
  • Hybrid vesting: Combines both time- and performance-based components.

Until vesting occurs, restricted shares generally cannot be sold or transferred. The vesting schedule also affects rights such as voting and dividend eligibility, especially for RSUs which don’t represent actual share ownership until vesting is complete.

Advantages and Disadvantages of Restricted Stock

Advantages of restricted stock:

  • Shareholders can have dividends or voting rights at the company's discretion.
  • Even if the share price goes down, restricted stock continues to carry some value for employees.
  • Since awards carry value regardless of whether the share price decreases, restricted stock shares carry similar benefits as and are less complicated than options.

Disadvantages of restricted stock:

  • Restrictions could make it less likely for an employee to own stock. If an employee were looking to buy shares, especially if they weren't purchased at a price reduction, restricted stock may not seem like a very attractive buy.
  • If the company's stock does not gain the worth that the company intended, restricted stock won't have much value.
  • Restricted stock can carry some financial risks.

Restricted Share Rights: Dividends, Transfer, and Forfeiture

Restricted share rights may include or exclude:

  • Dividends: Some plans pay dividends on unvested restricted stock, but this varies. RSUs typically do not pay dividends until shares are issued.
  • Transfer rights: Restricted shares cannot usually be sold, transferred, or pledged before vesting.
  • Forfeiture: If an employee leaves the company or fails to meet performance goals, unvested shares are often forfeited.

Additionally, the company’s plan documents and state law will define whether unvested restricted shares grant voting rights or dividend equivalents. Generally:

  • RSAs may allow voting rights from the date of grant.
  • RSUs typically do not allow voting rights until vested and converted into actual shares.

Restricted Stock Units

Restricted stock units (RSUs) are commonly issued by employers instead of restricted shares. Though similar to restricted stock, RSUs have additional features that, in some ways, make them preferable to stock.

RSUs are essentially an employer's promise to pay the employee a specified number of shares when the employee has completed a vesting schedule. These units have no real value until vesting is complete. RSUs follow vesting schedules and don't directly pay dividends; however, they could pay the equivalent of a dividend toward withholding taxes or be reinvested into more shares.

RSUs are closely related to restricted stock and have many of the same advantages and disadvantages. Key advantages RSUs have over restricted stock include:

  • Potentially lower taxes.
  • Deferral of share issuance. Employers are able to issue RSUs without diluting the company's share base.
  • Low cost. The administrative cost of RSUs is lower since there aren't any shares to hold, record, or track.
  • Tax deferral. Taxation can be deferred beyond the vesting date if the company delays issuing shares to employees.
  • Reduced foreign tax hassle. Issuing RSUs to non-U.S. employees can make taxation easier given differences in how and when stock is taxed.

Not all of the differences between RSUs and restricted stock are positive. RSUs don't have:

  • Voting rights until shares have vested and are formally issued.
  • Dividends, as no shares are actually in use.

Restricted Stock Awards

Restricted stock awards are often used as a means of paying employees in lieu of stock options, which are losing popularity. A key reason why restricted stock is preferred over options is the reduced charge to income that restricted stock awards provide.

Restricted stock awards, like RSUs, allow companies to reward employees by awarding stock on top of compensation. Restricted stock will vest after a certain period of time; however, the employer usually stipulates that the stock will not vest if the employee leaves the company voluntarily, is fired, or doesn't meet specified performance objectives.

Big differences exist between restricted stock awards and RSUs. Mainly, restricted stock awards carry voting rights effective immediately since the employee is the legal owner of the stock from the moment the stock is granted. RSUs are representative of the right to stock rather than the stock ownership. In addition, restricted stock awards can't be cashed in, which is sometimes possible with RSUs.

Comparing RSAs and RSUs: Ownership and Tax Timing

A key distinction between RSAs and RSUs lies in ownership timing and taxation:

  • RSAs: Shares are issued at grant, but subject to forfeiture until vested. Voting rights and dividends may apply from the grant date. Recipients may choose to make an 83(b) election, allowing them to pay taxes upfront based on the fair market value at grant.
  • RSUs: Represent a promise to deliver shares in the future. No taxes are due until vesting, and there are no voting rights or dividends until shares are issued.

Choosing between RSAs and RSUs may depend on an employee’s tax strategy, risk tolerance, and company policy.

Tax Implications of Restricted Shares

Understanding how restricted shares are taxed is crucial:

  • Without 83(b) election (RSA): Taxes are due when shares vest, based on the fair market value at that time.
  • With 83(b) election (RSA): Taxes are paid at grant, potentially minimizing tax liability if the share value increases later.
  • RSUs: Taxed as ordinary income at the time of vesting based on the fair market value.

In both cases, any future gains after vesting are treated as capital gains upon sale. It’s advisable to consult a tax professional to assess whether an 83(b) election aligns with your financial goals.

Frequently Asked Questions

  1. What are restricted share rights?
    Restricted share rights refer to the limited privileges associated with unvested shares, such as restrictions on transfer, limited or no voting rights, and possible forfeiture.
  2. Do RSUs have voting rights?
    No, RSUs do not have voting rights until they vest and are converted into actual shares.
  3. Can restricted stock earn dividends before vesting?
    It depends on the company’s plan. RSAs may provide dividends or dividend equivalents before vesting, while RSUs usually do not.
  4. What happens if I leave my job before my restricted stock vests?
    Unvested restricted shares or units are typically forfeited upon resignation or termination, unless otherwise stated in the plan.
  5. Should I make an 83(b) election on restricted stock?
    An 83(b) election can offer tax advantages by allowing early taxation, but it involves risk. Consult a tax advisor to determine if it’s the right move.

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